The central economic problem right now in the United States is that we spend more than we make in a variety of different ways -- in the federal budget, through consumer debt, in trade with other countries. The process of shedding debt and increasing savings is the natural response to the financial crisis and recession, but it's not a very pleasant one, since those cutbacks have all kinds of bad macroeconomic side effects: Less spending and investment, public and private, means less demand, which means slower growth and fewer jobs.
So the main question for policy-makers today is, "How do we affect this rebalance with as few nasty economic side effects as possible?" This is why folks like Matt Yglesias and yours truly have been harping more and more on revaluing our currency relative to those of other countries, particularly China. Here's Matt with a useful insight about what would happen if we succesfully convinced China to revalue its currency, the Renminbi, in response to Steve Pearlstein's call for wage cuts:
[R]evaluation is the same thing as lower wages for American workers. Almost everyone in the United States earns money according to a formula denominated in dollars. So if dollars become less valuable relative to other important currencies, our real compensation declines. By the same token, if the Federal Reserve succeeds in raising the price level, our real compensation declines. ... if you reduce real compensation via currency devaluation or higher inflation you reduce income and debt alike allowing us to dig out of the balance sheet hole more quickly.
Basically, it's not smart to cut peoples wages but not their debts when you can reduce both. Chris Hayes had an insightful report about this over a year ago, arguing that higher inflation is the key to shedding some of our crushing debt load.
-- Tim Fernholz
